The Real Price of Gold Holds the Cards for Gold and Gold Shares

We often write about the real price of gold (RPG) as it is a leading macro
indicator and leading indicator for gold stock fundamentals. The RPG is simply
a measurement of Gold in terms of various markets such as commodities, stocks
or currencies. If the RPG is broadly outperforming then it could be signaling
credit stress and even an economic contraction. If equities and commodities
are outperforming Gold then it signals an improving economic environment and
an improving credit environment. We also note that a strengthening RPG in itself
is a catalyst for improving margins for gold miners. Furthermore, since a rising
RPG is a contractionary signal, it can also be a catalyst for Fed action. The
RPG appears to have bottomed and looks likely to trend higher in the coming
months.

Note that during the financial crisis of 2008, the real price of gold began
rising several months before gold itself. In the chart below we plot gold,
gold/commodities, gold/foreign currencies, and gold/stocks. gold/commodities
bottomed in June while gold bottomed relative to both currencies and stocks
in September. Turning to the present, we see that gold/commodities has maintained
an uptrend during a corrective period while gold priced in foreign currencies
has rebounded from support and while gold relative to stocks may have just
bottomed.

As we've written many times, the RPG can be a leading indicator for the miners.
Below we show the HUI/gold ratio, the HUI, the gold/oil ratio and gold/industrial
metals ratio. Note that significant advances in the gold/oil and gold/metals
ratios initiated two strong cyclical bull moves in the gold stocks from 2001-2003
and from 2008 into 2011. If those ratios rise to new highs then it would definitely
signal the inception of a new cyclical bull in the gold stocks.

While the RPG surged into the 2011 Euro crisis, it wasn't sustained as the
crisis abated and there was no real threat to the economy. However, at present,
the RPG is starting to move higher as the Euro crisis intensifies and as economic
data continues to disappoint. If these troubles are only temporary then gold
stocks will remain in a cyclical bear market. However, if these troubles persist
through the summer and into the fall then they should kick-start the next cyclical
bull market in the gold equities and a move in Gold to $2000/oz. The reason
is simple. Persistent credit stress and a weakening economy will require more
Fed action and action from the ECB.

The former is painful as it creates volatility and liquidation events but
it also creates opportunities. We saw it in 2008 and we are seeing it now.
With regards to the gold shares, proper stock selection is paramount as select
stocks will dramatically outperform GDX and GDXJ, even as they recover. GDX
recovered more than 300% in a little more than two years. Sounds fantastic
right?

Check out the gains from producers over a two and a half year period. These
were producers and not exploration or development companies. Now we are not
implying that these numbers will be duplicated from 2012-2014 but it is certainly
possible since many stocks will be starting from low levels. Simply put, the
growth-oriented producers offer the best risk-reward and we urge you to focus
the bulk of your capital on this segment of the market rather than speculating
on risky exploration stocks.